Gold has had one of its best years in recent history. Since the start of the year, gold in dollars is up 32%. Much of the gain occurred in the first few months of the year, when the U.S. announced its global tariff regime. Gold has performed strongly in the last one month, as geopolitical uncertainty has increased, and the U.S. Federal Reserve is expected to cut interest rates.
Some of the rise in gold is due to central banks shifting away from holding US dollar reserves. The US dollar is down by 11% since the start of the year, with most of that fall occurring in the first few months. Central banks aren’t just dumping US dollar reserves. Bond yields across Europe and Japan have increased, indicating falling demand for government bonds in general. Gold is slowly replacing other currencies as the reserve asset of choice.
It is possible, though not yet probable, that gold becomes the dominant reserve currency. For this to happen, the global economy would have get much worse. Inflation would have to go up everywhere. Trade and GDP would have to fall. This has not happened yet. But gold’s recent rise is a clear indicator that some investors and central banks are worried.
The bull in the room: A stock market disconnect
The doom and gloom narrative seems compelling, right? But there’s a major problem with this narrative. And that is the stock market. The stock market continues to signal optimism. The Nifty index is up 5% this year, and S&P 500 index is up 9%. The US stock market is at a record high, while the Indian stock market is close to its record high made at the end of June.
The VIX index, that measures US stock market volatility is at 14.5. The India VIX index, that measures Indian stock market volatility, is at 10.1. Both are near or below long-term historical averages. There is no sign of bad news coming from the stock market.
There is clearly a disconnect between what gold and the stock markets are telling us. The gold, currency, and bond market all signal bad news. The stock market tells us that everything is fine. Sooner or later, one of these markets will correct. Which will it be?
A tale of two investors: Retail vs. Institutions
One clue here is the presence of retail investors. Retail investors have the unfortunate reputation of being wrong more often that institutional investors. In both gold and the stock market, retail investors have a large presence. In currencies and bonds, they are small. These two markets are driven primarily by institutional investors.
Given moves in bond and currency markets, it is likely that institutional investors are pessimistic right now. Since gold and stocks are going up together, it tells us that retail investors are more optimistic but are also hedging their bets. (It is not uncommon for retail investors to buy stocks and gold at the same time).
Time will tell which group is proven correct. If history is a guide, institutional investors have historically done better than retail investors.
Note: The purpose of this article is to share interesting charts, data points and thought-provoking opinions. It is NOT a recommendation. If you wish to consider an investment, you are strongly encouraged to consult your advisor. This article is for strictly educative purposes only.
Asad Dossani is an assistant professor of finance at Colorado State University. His research covers derivatives, forecasting, monetary policy, currencies, and commodities. He has a PhD in Economics. He has previously worked as a research analyst at Equitymaster, and as a financial analyst at Deutsche Bank.